Sharia'h Boards

With demand for Shari’ah-compliant financial services growing at a faster rate than conventional banking, Shari’ah boards play a vital role in helping to develop new procedures and products to position the Islamic bank to adapt to industry trends, and customers’ expectations. In fact, Islamic financial products must be structured to conform to strict legal and Shari’ah requirements. Shari’ah Boards play an important role in that sense as they help ensuring that the issued financial products strictly adhere to the principles of Shari’ah and offer constructive and creative recommendations to maintain Islamic banking system in line with the continued challenges of working in a sophisticated and ever-changing financial environment. In addition, by showing flexibility based on their Ijtihad, Boards scholars help to respond to changes and diversity in day to day life by taking into consideration concepts of custom, general good, utility or necessity while remaining within the Islamic law boundaries. The role of the Shari’ah board involves the reviewing and overseeing of all potential new product offerings. It has a significant investigatory function to interpret different financial concepts and determine whether or not this they include non-permissible transactions such as Riba. It also provides the necessary expertise to create alternative framework of banking services which conform to the principles of Islam. The board continually adapts itself to the rapidly changing financial environment to apply the original Islamic philosophy to contemporary problem, while at the same time requiring the greatest adherence to the political, social and economic precepts of Islam. Board’s members are in charge of the review, the approval, and supervision of all Shari’ah product offerings. Therefore, the board should work closely with product development teams, legal department, tax advisors and compliance departments to offer practical advice as to how to legitimate or amend conventional structures in order to make them Shari’ah compliant without compromising or deviating from the Shari’ah essentials and without being diluted in the conventional banking system. Shari’ah Boards are now able to cope with the developmental problems using various forms of financial transactions, such as Mudarabah, Musharakah, Murabahah and Ijarah. They drafted out the model agreements for these modes of financing; Banks are bound to follow these forms in all their transactions in letter and spirit. And for this reason, boards adopt procedures to ensure that all business transactions are submitted to it for approval before being acted on. Management is required to periodically report and certify to the Board regarding the conformity of the actual investments. Shari’ah Boards should also be notified whenever a case arises where there are difficulties in applying any of these forms; they would then come to decision and issue a fatwa which the management of the bank must follow.

Shari’ah compliance

Achieving Shari’ah compliance is of crucial importance for integrity and credibility of Islamic banking and finance; and the Shari’ah board is a key element of the structure of Islamic banks to ensure that compliance within the business of Islamic financial institutions. By carrying the responsibility of ensuring that all offered products and services are fully compliant with the principles of Shari’ah, Shari’ah board contributed to the public awareness about the philosophical basis and the concept of Islamic banking and finance. Shari’ah compliance is not just restrictive in regard to investment in companies with unacceptable business; it also includes a promotion of investment in businesses that contribute to the ethical values of Islam and purification of bad profits by distributing them to charity for the welfare of the community as a whole.
According to AAOIFI standard, Shari’ah Board should be an independent body of specialised jurists in Islamic commercial jurisprudence. It may also include other experts in areas of Islamic financial institutions with knowledge of Islamic jurisprudence relating to commercial transactions. Board members with specialized knowledge of particular aspects can work very effectively on sub-boards related to particular initiatives or projects. Their important duties include analysing unprecedented situations in the bank’s transactional procedures or those reported by different departments and even the customers. This is to ensure Shari’ah compliance before the bank develops any new products or implements any new procedure. Its role is also to analyse contracts and agreements concerning the bank’s transactions and to ensure Shari’ah compliance in the implementation of all banking transactions, correcting any breaches and preparing regular reports on the bank’s balance sheet with respect to its Shari’ah compliance. The fatwas and rulings of the Shari’ah supervisory board are binding on board of directors of the Islamic financial institution. The board should also supervising Shari’ah training programmes for the Bank’s staff.
Shari’ah boards exist in all individual Islamic banks, but also in global institutions like Islamic Fiqh Academy of the OIC, the IDB and the IIFM, and in national central banks of some Islamic countries. All these committees have issued a large number of fatwas covering many of the current practical problems of Islamic banks. Islamic financial Institutions must ensure that Shari’ah boards should have a high level of autonomy and independence, protecting them from commercial pressures to enhance the credibility of their institutions and of the Islamic banking system in its alternative approach.

Supervision

The supervision of Islamic banks’ transactions for the purpose of Shari’ah compliance is one of the main functions of Shari’ah Boards of Islamic Financial Institutions. Shari’ah Boards should meticulously inspect at least once a year the activities of Islamic banks to ascertain their Shari’ah compliance. Controls would include prohibition of investment in companies with unacceptable business lines which produce prohibited products and provide prohibited services. They also include ensuring that financing modes that are linked to fixed rates of return and investments in capital markets are conform to Shari’ah principles. Any income from investment in equities of prohibited companies or from Riba will have to be given in charity and the Shari’ah Boards must make sure it has been credited to charity accounts.
Shari’ah Boards should clearly specify detailed controls and monitoring in respect to Shari’ah compliance that have to be carried out for the different modes of financing, in particular for modes which are susceptible to be used as back-door to interest such as Murabahah and Ijarah. For example, in case of Diminishing Musharakah, the Shari’ah Board can oversee the different documents relating to creation of partnership, leasing and sale of units to the other party, all expenses relating to ownership must be borne by the parties in the proportion of their ownership, and the rate of Musharakah payments should be net of such expenses and not directly linked to any benchmark like LIBOR. The board should also control that no rental should be charged if the jointly purchased asset is not capable of being leased. Shari’ah board also ensures that the Islamic bank fulfils the necessary Musharakah requirements, that profits are distributed among shareholders and various categories of depositors according to disclosed criteria and ratios and that any loss is borne by the partners exactly in proportion of their share in the joint investment. In the case of Murabahah, Shari’ah Board should ensure that accounting on Murabahah transactions follows AAOIFI’s Accounting Standard that requires it to be treated as a trade transaction and not as a financial transaction. The Board should restrict the bank from any roll-overs in operations related to Murabahah such as recording only the disbursement of the total amount including mark-up. The Shari’ah Board should put in place effective controls that banks do not resort to buyback technique and to ensure that customer purchases the commodity within a given minimum time and declares it to the bank which in response accepts the transaction and sales the commodity to the customers. Besides, Shari’ah Board must ensure that legal title of ownership is transferred to the bank before it sells the commodity to the customer and that bank retains all risk and rewards related to ownerships till the goods are sold to the customer. There should also be a control on documentation requirements to ensure that are being properly fulfilled and no change in the master agreement should be allowed without the board’s prior approval. The other major Islamic financing mode that needs specific controls is Ijarah. The Shari’ah Board should ensure that ownership title of the leased asset is transferred to the bank and that expenses relating to purchase and ownership of the asset are borne by the Islamic bank. Accounting for this mode of financing should be similar to that of the operating lease instead of finance lease. If rentals are received in advance, they should not be treated as a liability.